We wrote it. Did you short it?
Goldman eventually admitted it had insured roughly $20 billion worth of subprime CDOs with AIG and had major exposure to the firm. But the New York Federal Reserve and Goldman Sachs never revealed this critical fact: Goldman didn't merely buy insurance on a bunch of random subprime CDOs. It actually bought insurance on special CDOs it had put together and sold to its own clients. In other words, Goldman knew more about these CDOs than anyone else. Goldman bought insurance on these CDOs because it knew they'd collapse. This is tantamount to building a house, planting a bomb in it, selling it to an unsuspecting buyer, and buying $20 billion worth of life insurance on the homeowner – who you know is going to die!
These facts all came to light because of research done by the office of Darrell Issa, the ranking Republican on the House Committee on Oversight and Government Reform. These new documents will certainly lead to a full investigation of the Goldman-AIG dealings and the subsequent $180 billion bailout led by the New York Federal Reserve. My bet? Heads will roll. If you own Goldman Sachs, you'd better sell. – Porter Stansberry, February 24, 2010, S&A Digest
Last week, the SEC targeted Goldman Sachs in a civil fraud case. The lawsuit alleges Goldman sold investors a collateralized debt obligation (CDO) linked to the performance of certain mortgages without disclosing John Paulson's hedge fund, Paulson & Co, helped design the product and was betting against those mortgages.
Paolo Pellegrini, Paulson's lead mortgage analyst, worked with Goldman to pick a group of mortgages most likely to be downgraded. Paulson & Co then paid Goldman $15 million for the service. ACA Financial, a bond insurance company, made a few changes to the structure of the product. Then Goldman sold these to its clients, who readily bought because of their triple-A rating. John Paulson made $1 billion from his bets against this particular mortgage product, named Abacus. The buyers, which included ACA Financial and the German bank IKB, lost $1 billion.
The idea behind the SEC's lawsuit is these mortgage securities were fraudulently constructed: They were made to fail. If the SEC is able to prove its case in court, the ramifications for the other banks that put together CDOs will be tremendous. For example, a judge last week rejected Merrill Lynch's motion to dismiss an MBIA lawsuit over billions in mortgage backed CDOs that MBIA had insured. The judge ruled the insurance contracts were based on the securities' triple-A rating. Since the triple-A rating might have been fraudulently obtained, the lawsuit should continue. If these suits aren't settled, the big banks could end up losing hundreds of billions to the insurance companies and other mortgage investors.
New high: Prestige Brands (PBH).
In the mailbag... a few kudos on our long campaign against Goldman Sachs, plus an interesting question about how to use our letters in a stock market that's increasingly overpriced. Questions here: feedback@stansberryresearch.com.
"He's done it again, folks. He warned us about GM, Fannie and Freddie and Goldman.
"Although Goldman won't fold, for years, you've warned us that Goldman (and just about every other investment bank) simply does not work in the interest of the people to whom it sells investment products. Caveat emptor to the quintessential level, for sure. Kudos to your insight. Keep it up." – Paid-up subscriber Mike P.
"I, too, thought it was amazing. Forwarded it to my son. Subject 'amazing Advice' and continued to say: from our buddy to a young man. Also, amazing that he replied to him so thoughtfully and in such depth. Porter and all of you are remarkable!! Grace a dieu there are some of you out there. Now my question is: Goldman? Didn't Porter point to something like this?" – Paid-up subscriber SW
"As a recent paid up subscriber (PW Alliance, also Extreme Value), I am reading recommendations carefully. But how safe are any of the recommendations when I keep seeing 'stock market is overvalued' and 'could be 20% or more drop,' etc. Do I ignore the recommendations and sit on the cash at 1% return?" – Paid-up subscriber Mitch Davidson
Porter comment: We warn our customers when we see signs the market as a whole is unattractive for new investment. We do so not because we're confident in our timing – which is almost surely going to be wrong – but because if our roles were reversed, we'd expect you to share your opinion on the market's relative value and safety. On the other hand, people only pay for newsletters that offer advice. It's our job to find ways for you to make money investing, whether the market is overvalued or undervalued.
Right now, it seems like the market is moderately overvalued. This makes our job considerably harder. And it makes investing in stocks considerably more risky. However, you should remember this... You are unlikely to be ready and able to buy stocks at the bottom of a bear market if you're not familiar with the stocks you're going to buy. I recommend following our letters even during periods when you're not actively putting new money to work. When stocks begin to trade at very attractive prices, you'll be educated and ready.
"My son did not complete his loan modification application because Bank of America requires submitting three years of tax returns to show that there is no other money that they can tap into." – Paid-up subscriber Richard
Porter comment: I have no sympathy for investment banks that took on fiduciary obligations when they packaged mortgages into securities and sold them to investors as "triple-A rated" investments. Likewise, I have no sympathy for homebuyers – perhaps like your son – who agreed to repay loans that they couldn't reasonably afford. If you borrow money, you ought to pay it back. If you build an investment product, you ought to stand behind it. These seem like obvious and simple ethical calls to me.
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
April 19, 2010